This week, the US Internal Revenue Service (IRS) handed Israel a golden opportunity on a silver platter. Or, shall I say, a virtual gold opportunity. By deciding to tax Bitcoin as an asset, like gold, the US Government effectively doomed Bitcoin as a currency. As Robinson Meyer correctly writes in The Atlantic, “To tax Bitcoin as property…destroys its fungibility: One Bitcoin can no longer be exchanged for another…This was one of the original intents behind the service. Bitcoin aimed to function as a kind of digital money, meaning it had to work as a unit of account, a medium of exchange, and a store of value.”

To be clear, this does not doom Bitcoin. The protocol and architecture of the blockchain based ledger will still enable endless disruption of existing industries. However, it does cripple some of the nascent US-based entrepreneurial efforts to boost Bitcoin-based commerce until the currency abstraction layer arrives on top of the Bitcoin blockchain. This tweet from Chamath Palihapitiya is instructive in that regard:

“Bitcoin is too complex for mass market. Need an abstraction so it can be used by people who don’t care how it works” @chamath#coinsummit

Meyer, quoting Prof. Levitin of Georgetown, points out just how complex this tax treatment is for the common man:

The price at which a particular Bitcoin was acquired (and this is traceable) determines the capital gains on that particular Bitcoin when spent. If I spend Bitcoin A, which I bought at $10, but is now worth $400, I’ve got a very different tax treatment than if I spend Bitcoin B, which I bought at $390. […] This means Bitcoins are not fungible, and that makes it unworkable as a currency.

I believe this opens the door for another jurisdiction, with appropriate regulatory and tax regulations, the right technology ecosystem and interested entrepreneurs to become the epicenter of Bitcoin and virtual currency innovation. Israel should become exactly that place.

Israel is currently working on its Bitcoin regulatory framework. The Bank of Israel and Israeli Tax Authorities should treat Bitcoin as a currency and apply sure but light regulation. They should not, as Prof. Danny Tziddon suggested at our Aleph Bitcoin event, simply follow the US Federal Reserve or government. The Israeli regulator should “zag” where the US “zigged.” They should take a simple approach and not the United States’ complex approach. This would increase the velocity of Bitcoin purchased by Israelis by making it a medium of exchange. That increased velocity, and hence use, would also speed the innovation around Bitcoin, its protocol and the general commercial applications of virtual currency in Israel. Critically, it will also attract global Bitcoin entrepreneurs to Israel.

Israel already has a critical mass of the crypto expertise and the entrepreneurial verve to enable Bitcoin innovation to flourish here. We also have another advantage: we are a small country, a community, with our own currency that is not the World’s reserve currency. Our economic system is not threatened by the emergence of a digital and decentralized currency. Our community ethos breeds trust, which is so necessary for new currencies (more on that in my next post) Hence, Israel can uniquely enable virtual currency to flourish and innovation to flourish around this digital currency revolution. We are one of the few countries that stands to gain more as a country from the export of innovation engendered by Bitcoin and virtual currencies than we stand to lose by having an alternative currency to fiat currency. Hence, we should be encouraging our legislators and regulators in Israel to be avant guard, daring and world leading in their policy approach toward Bitcoin and virtual currencies.

Thanks to Eran Shir and Eden Shochat for looking at early drafts of this post.

Michael Eisenberg has been a key figure in Internet and software investing in Israel since 1995, playing a central role in the development of many of Israel’s leading companies and startups.
In 2013, Michael launched Aleph, a $140MM early stage venture fund together with Equal Partner Eden Shochat. Aleph focuses on building big companies out of Israel and servicing the hell out of entrepreneurs.
Prior to founding Aleph, Michael was a General Partner at Benchmark from 2005-2013. Prior to that, Michael was a partner at Israel Seed Partners for eight years. Michael joined Israel Seed in 1997 from Jerusalem Global, where he started and headed the firm’s successful investment banking group and partnership with Montgomery Securities.